What’s in a Scenario?

Last week, we discussed how our algorithms factor in new, unprecedented scenarios, such as COVID-19. But which particular variables have the biggest impact on the overall risk scenario? This was a question put to us by another one of our clients. 

There is no “super variable”. Of course, not all variables are created equal. But the key thing to bear in mind about the coronavirus crisis is that although the pandemic itself affects risk – the government responses to it matter even more.

During the “Great Shutdown”, unemployment has soared just as GDP cratered (The Federal Reserve Bank of New York is “nowcasting” a 25% annualized drop in second-quarter U.S. GDP). In previous dips, such as the financial crisis of 2008, economic growth and joblessness were trailing indicators. This time round they’re leading indicators. 

That said, the COVID-19-related variables that matter most will depend on the organization’s specific exposures: moves in USD/GBP will only matter tangentially to an institution that has little or no exposure to it (though there may be hidden risk concentrations to which organizations have only indirect exposure, but which still matter). So what’s important is to identify which variables are most critical to you and your company. 

We can do this almost instantaneously: first, by identifying the variables that are most impactful for an organization’s risk outcomes; and second, by discovering baseline and risk scenarios from the 10,000 we generate.

A number of clients have realized it’s not just their risk scenarios that need to adapt to the new situation; but their baseline scenarios, too. For most institutions, GDP and credit spreads are the scenario variables that matter most. The rest will depend on the type of organization: for retail and unsecured lending, unemployment and VIX can be critical; for project finance lending, it might be oil prices. So the short answer to the question of which particular variables have the biggest impact on the overall risk scenario is: it depends. 

Stay tuned for more on managing your balance sheet risk in the face of COVID-19. Or reach out to us at alla@straterix.com

ALLA GIL IS CEO AND CO-FOUNDER OF STRATERIX